Case Study

The Problem: Lance Fried planned to sell his waterproof MP3 players in surf shops. But could he really say no to the big-box retailers?

At first, Lance Fried was elated. The CEO of Freestyle Audio had spent months slaving over his invention -- a waterproof MP3 player designed specifically for athletes who want to rock out while surfing, swimming, water-skiing, or snowboarding. In classic bootstrap fashion, Fried had invested his personal savings and somehow convinced half a dozen friends to work for him for free. Now he heard some amazing news. Several major retailers -- including Best Buy and Bass Sporting Goods -- wanted to put his gadget on their shelves alongside popular players by giants like Apple and Sony. A deal with just a single big chain, Fried knew, could instantly push sales over $1 million.

But the more Fried thought about it, the more nervous he became. Pursuing mass retailers had never been part of the San Diego start-up's plan. Instead, the idea always had been to start small, selling through specialty shops. Pursuing a big-box strategy meant crafting an entirely new business plan -- one that would involve mass production and a potentially huge up-front investment. What's more, the retailers wanted the players in time for the holiday shopping season, which was just four months away.

Fried, an electrical engineer and product design whiz who last served as CEO of an apparel company, got the idea for a submersible MP3 player while watching surfers near his home in Del Mar. Then, in late 2003, a friend dropped an iPod into a cooler full of water and ice, rendering the device useless. Fried got to work designing his waterproof player. By August 2004, a prototype was ready. It was lightweight (40 grams), with a 40-hour battery and 512MB of flash memory, capable of holding about 80 songs. The headphones wrap tightly around a swimmer's ears, and all of it is waterproofed using a proprietary technology. He planned to sell the units for $180 a pop.

Enter Greg Houlgate. A friend of Fried's who served on Freestyle's board and had worked as a sales strategist for a number of large sporting goods companies, including Callaway Golf, Houlgate showed the player to some of his contacts in the big-box retail world. "I've never had such a quick and positive response on any consumer electronics," he says.

The question was how -- or for that matter, whether -- to capitalize on that interest. Fried quickly convened a meeting of his three-man board at Jimmy O's, a local oceanview hangout. Houlgate presented the good news to the third partner, Mike Brower. "Mass distribution gets your name out fast and gives you an instant hit," Houlgate said. "Your vendors really start to take you seriously." That wasn't the only advantage. With mainstream retailers on board, it would be easier to attract investors. That appealed to Fried, who was growing tired of depleting his own bank account.

But Brower, CFO of the popular sunglasses company Spy Optic, was wary. He'd worked at plenty of sporting goods companies and had always succeeded by starting small, becoming a hit with an influential niche group, and going for bigger distribution deals only after that groundwork had been laid. How, he wondered, would Freestyle get its key customer groups -- surfers and snowboarders, both of them notoriously anticorporate -- into big, decidedly unhip retail outlets? And what would Freestyle have to give for the privilege of a good position on big-box shelves? "They'll make you a commodity if you don't know how to negotiate, asking for discounts that just kill your margins," Brower said.

Meanwhile, ramping up production would require a significant capital investment. How could Freestyle find that kind of money? Would the company's manufacturing partners be able to maintain quality if orders suddenly spiked? How would the company shout louder than competing MP3 player brands manufactured by corporate giants and backed by multimillion-dollar marketing campaigns?

Time was running out. The three-day action sports retail trade show -- where independent retailers go to test and order new gear to sell at their surf, dive, skate, and snowboard shops -- was just weeks away. Making a big splash at the show had always been part of Freestyle's plan. If Fried signed on for a big-box deal, that plan would have to change.

The Decision

Fried asked Houlgate to call his contacts at the big boxes and respectfully decline their offer. They were not easy calls to make. "I told them, 'We have to push back from this wonderful opportunity. We're not ready," Houlgate says. "So many people go into deals and overextend themselves. Then everyone is dis- appointed. Hopefully it was refreshing for buyers to hear 'no' from us, and that we'd come back later."

Instead, the Freestyle team focused on preparing for its big trade-show debut, creating a dis- play that seemed certain to turn heads: The players would sit in the bottom of fish tanks, with the headphones dangling out so anyone could come by and have a listen. "We were swamped," says Fried, who estimates that some 1,800 visitors stopped at the booth. About 40 small and midsize retail shops prebooked orders for the spring of 2005. Surfer magazine put the waterproof MP3 player at the top of its Christmas wish list, calling it "a dream come true."

In addition to retail buyers, marketing and licensing executives from some of the surf world's biggest brands, including Quiksilver and Oakley, visited the booth. After sampling the player, the execs sought to explore co-branding opportunities -- a source of revenue that Fried and his partners had not even considered. A deal with Liquid Force, a major manufacturer of wakeboards and accessories, is cur- rently on the table; it could bring the MP3 player into more than 1,000 independent stores in 48 countries.

The strategy of selling through specialty retailers and co-branding with bigger, better-known brands makes more sense than pursuing mass retailers, Fried and Brower say. Sitting on the shelf at a big box, Freestyle's gadget could get lost among other MP3 players. But in surf shops, "we're the only game in town," Fried says, which will build credibility with finicky Gen-Y consumers. Even Houlgate, who negotiated with the big boxes and was hoping for a smash hit, agrees. Houlgate estimates that Freestyle could have grossed $20 million in 2004. "But it's a huge expenditure to get that production moving," he says. Ultimately, he hopes his partners will reconsider going mass market. But building credibility with hard-core enthusiasts, he says, "will give these chains greater success in selling to the masses when the time comes, if it ever does."

As for the 2004 holiday season, Freestyle opted to avoid retailers altogether and sell the MP3 players directly through its website. The devices proved so popular that the company ran out of them on December 23. Even with the small-store strategy, Fried expects 2005 sales to hit $10 million. "With 4.9 million surfers, 3 million wakeboarders, 8 million snowboarders, and 10 million water rafters and kayakers," he says, "we're looking at a lot of demand."

The Experts Weigh In

Should Freestyle Audio shun the big boxes?

In my experience, mom-and-pop retailers take time to educate consumers about your product and can create strong brand loyalty. But I worry that smaller stores, unlike Best Buy or Circuit City, will lock up MP3 players in glass cases where nobody will notice, or steal, them. Freestyle Audio needs to make sure the players stay out in the open. And, since these are music players, wouldn't it pay to learn what bands a surfer audience loves and partner with them as well as surf brands?

Charles Melcher
CEO, Melcher Media, specialty book publisher, New York City

Freestyle Audio would have gained visibility by going through big-box stores and not lost credibility with surfers. That's where people go to get MP3 players. It now has to develop a market itself, which is capital intensive. As far as co-branding with the likes of Quiksilver, the danger there is that it can eclipse its own brand and become known as Quiksilver's waterproof iPod. Then it has helped its partner without making a name for itself.

David Stewart
Marketing professor, University of Southern California

Every surfer has a different rhythm and every wave does too. It would be interesting to see how you would surf differently listening to music. As far as selling this thing, people who go to surf shops are looking for sunscreen, clothes, or equipment. They're not thinking, "This is where I'm going to buy an MP3 player." Freestyle Audio should invest heavily in marketing, do a TV commercial if possible, and develop great point-of-sale displays to let people know what this player is and where they can buy it.